In which case would people desire to borrow the most?

a.

the nominal interest rate is 8% and the inflation rate is 7%

b.

the nominal interest rate is 7% and the inflation rate is 5%

c.

the nominal interest rate is 6% and the inflation rate is 3%

d.

the nominal interest rate is 5% and the inflation rate is 1%

Question

In which case would people desire to borrow the most?

a.

the nominal interest rate is 8% and the inflation rate is 7%

b.

the nominal interest rate is 7% and the inflation rate is 5%

c.

the nominal interest rate is 6% and the inflation rate is 3%

d.

the nominal interest rate is 5% and the inflation rate is 1%

BlackTom AI · Accepted Answer

To assess who would want to borrow the most, we should compare the real cost of borrowing, which is roughly the nominal interest rate minus inflation (real interest rate = i − π).
Option a: nominal 8% with inflation 7%. The approximate real rate is 1%. This is a relatively low real cost of borrowing, which tends to maximize borrowing demand because the borrower pays back with money that is less valuable, and the incentive to borrow is strong.
Option b: nominal 7% with inflation 5%. Real rate ≈ 2%. While still low, the real cost is higher than in option a, so the borrowing incentive is somewhat weaker than in a.
Option c: nominal 6% with inflation 3%. Real rate ≈ 3%. The higher real rate compared to a and b reduces the attractiveness of borrowing relative to those options since households and firms must repay more in real terms.
Option d: nominal 5% with inflation 1%. Real rate ≈ 4%. This is the highest real cost among the options, making borrowing least attractive here despite a low nominal rate, because the lender is demanding more in real terms.
In summary, the option with the lowest real interest rate tends to spur the greatest desire to borrow, since borrowers repay in money with reduced purchasing power. Among the given cases, option a yields the smallest real rate (about 1%), making it the scenario where people would desire to borrow the most. The other options offer higher real costs of borrowing, which dampen the incentive to borrow relative to option a.

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